An exercise to update capital market

FINANCIAL SCENE Reform measures can never be viewed in isolation — their broad objectives are always on strengthening the capital market and protecting its investors.

After a board meeting on August 16, the Securities and Exchange Board of India (SEBI) announced some important measures to “revitalise” the primary market and “re-energise” mutual funds. Though in its announcement SEBI has divided the various measures into two categories, it must be understood that what is being sought to be reformed is the capital market itself, comprising the intermediaries, investors and, of course, the regulators, including stock exchanges.

Reform measures can never be viewed in isolation — their broad objectives are always on strengthening the capital market and protecting its investors.

Another reason why compartmentalisation does not help arises from the fact that there is a substantial overlap in the reform measures applicable to the new issue market and mutual funds. Mutual funds channelise investor funds to the stock markets. So does the primary market. The difference, of course, is that investors in the primary market take on far greater risks compared to mutual funds, whose fund managers, with their presumed expertise, help investors in managing their risks to a large extent. It is for this reason that mutual funds have been officially recommended as the preferred choice of first time investors. The SEBI board’s recommendation to extend the Rajiv Gandhi Equity Savings Scheme, a budget-notified tax savings scheme, to mutual funds is to be welcomed. In fact, the scheme should have been confined to mutual fund investments only.

That said, there are specific measures to increase the penetration of mutual funds and incentivising their distribution network. Fungibility of total expense ratio (TER) is allowed. This will help mutual fund manage their expenses better. In some cases, they can reward their distributors better.

There will be a simplification of the registration process of distributors. The base of mutual fund distributors will be expanded to include postal agents, retired government banks and certain others. SEBI will clarify as to what mutual fund products this newer category will distribute.

With a view to incentivising mutual funds to extend their coverage to beyond the top 15 tier cities, asset management companies (AMCs) are allowed to charge additional TER of up to 30 basis points on funds collected from these centres, subject to certain conditions (new inflows from these places should be at least 30 per cent of the total inflows). Investors will, therefore, pay more. Mutual funds shall disclose in the half-yearly reports of their Trustees to mutual funds their efforts at tapping funds from centres other than the top 15. Their reports will include details such as opening of new branches in those areas.

To spur investor education, the industry should set apart a portion of the asset management fees annually for investor education campaigns. In one more significant move to expand the coverage of mutual funds to small investors who may not be tax payers, cash transactions up to Rs.20,000 are being allowed, subject to certain conditions.

By way of strengthening the regulatory framework, AMCs will make monthly disclosures on their websites. Distributors will set up a self-regulatory organisation. Mis-selling of mutual fund products will be deemed to be a fraudulent and unfair trade practice in terms of SEBI regulations.

Primary market

The thrust of the new reform measures is on enhancing retail participation. That has been the avowed SEBI objective for a long time. However, retail investors remain disillusioned with the primary market. It is highly unlikely that the ongoing fine-tuning of existing regulations and rules will help overcome the scepticism and persuade small investors to invest in IPOs (initial public offerings) in large numbers. Even so, it is worth noting that SEBI has been doing its best from time to time

An important new measure is to make the IPOs more accessible to retail investors through the existing network of brokers at more than 1,000 locations. The facility of ASBA (application supported by blocked amount) is also being extended through this mode. Under this, investors get to keep their money until allotment, which will also be speeded up. Banks are being asked to extend this facility to all branches in a phased manner.

The most headline-grabbing of the SEBI announcements is the one relating to the allotment process. Every retail applicant, irrespective of the application size, will be allotted a minimum bid lot, subject to availability of shares in aggregate. The minimum application size for all investors is also being increased to Rs.10,000-15,000 as against the existing Rs.5,000-7,000.

While other measures to facilitate capital-raising by the issuers have been announced, it is obvious that the regulatory focus is on enhancing market integrity and enhancing investor confidence. In that context, most of the new measures, though appearing to be just tinkering of existing rules, are really part of a larger process of bringing the Indian capital market and its regulation up to date. Investor confidence is bound to go up.

At the moment, however, regulatory initiatives can help only that much. It needs quality issues to drive the market forward.